Is this the most rational way to invest?

Jun 9, 2011

In this issue:
» India presses forward to prevent food wastage
» Mobile tariffs may have bottomed out
» China warns US that a technical default could prove dangerous
» OPEC refuses to change supply quota for crude oil
» ...and more!
---------------------------------------------- Don't Miss! ----------------------------------------------

He's the Oracle of Omaha.

He's the world's most successful investor.

Your guess is right.

The Warren Buffett Quiz. Click Here to participate. It's Free!


Behavioural finance. No other subject has generated so much interest in finance in recent years as this one. And the interest too is not without reason we believe. You see, there is no dearth of smart, intelligent people in finance. In fact, it has attracted some of the best brains in the world in recent years. But still, the ability of the people in the financial world to either predict or avoid a big financial catastrophe is nothing but dismal. Crises have kept on happening with amazing regularity. Thus, it turns out that it's not things like aptitude and skill sets that are at fault. What has been actually responsible for the trillions of dollars worth of wealth reduction is this unique trait in us humans to turn completely irrational at times. And this is where the whole concept of behavioural finance fits in we believe.

Behavioural finance is nothing but the study of why otherwise rational people take some really dumb investment decisions. And it is being argued that an in depth knowledge of the subject can help one avoid a majority of investing mistakes. So far, so good we believe. However, does the study of the subject give you the necessary fixes in real life? May be not. It does give deep psychological explanations of investor mistakes but doesn't necessary tell you what to do in practical terms. Thus, there remains this huge gaping hole in the theory that is behavioural finance and its practical application.

But relax, there seems to be help at hand. And it answers to the name of value investing. We believe that value investing is nothing but behavioural finance in practice. It should be noted that what is central to value investing is the process of analysing financial statements, arriving at an intrinsic value and buying the stock if there is a margin of safety between the current price and intrinsic value. Now, isn't this is the most rational way to invest! And if it is indeed rational, then the purpose of studying behavioural finance is achieved according to us. This is because the aim of behavioural finance is to make us rational. But if we are already practising value investing, then we believe that we are anyways doing the most rational thing. Thus, those of you who are value investors seem to be already well versed with one of the biggest and most important breakthroughs in finance in recent times. And should we dare say are also on their way to reducing most of their investing mistakes.

Do you think value investing is the only rational way to invest? Let us know your views or comment on facebook page.

 Chart of the day
The US may be going through one of the toughest times in economic terms but that has not stopped the world's largest economy from flexing its military might. As today's chart of the day shows, the US was head and shoulders above the rest when it came to military spending for the year 2010. Despite having the world's largest GDP, its spending on a percentage of GDP basis was still the largest in the world. In fact, as The Economist points out, at close to US$ 700 bn, the US' defence spending is bigger than that of the next 17 countries combined. India spends quite heavily on military but in absolute terms it lags the firepower of its bigger, more powerful neighbour China. As per estimates, China spent nearly US$ 120 bn on defense in 2010 as compared to US$ 41 bn spent by India.

Source: The Economist

The telecom industry in India has witnessed cut throat competition since 2008. The competition was evoked by the entrance of multiple players in an industry that was hitherto dominated by a handful few. The result was the rock-bottom tariffs that we are all enjoying currently. Average Revenue per User (ARPU) has been declining ever since.

However, in recent times, the rate of decline has come down significantly. Most telecom operators feel that this suggests that rates have actually bottomed out for the industry. In fact to sustain healthy growth, the operators now expect ARPU to start trending upwards. The increase is expected to come from the growth in non-voice usage as well as from the premium 3G services. If this were to play out, mobile users may see their mobile bills becoming bigger in times to come.

The record since 2009 remains unbroken. OPEC refused to change supply quotas for crude oil yet again. But would a consensus to increase quota have helped? The formal supply limits are something that exists on paper. The cartel is already notorious for member nations flouting the fixed supply limits. An increase in supply would only have formalized it. However, there is a big lesson to take home from the meeting. OPEC, with a 40% share in global supplies is not concerned about the soaring crude prices and chooses to ignore the crisis in Middle East and North Africa. Stability in energy markets is the least of its worries and it only aims to make the most of high oil prices right now. While Saudi Arabia has already exceeded the fixed limit and will continue to do so, it sure will not be enough to take care of rising global oil demand. Even if it manages to keep oil markets well supplied, the spare capacities are poised to dwindle. This concern will keep the crude oil prices on the higher side.

The failed meeting has certainly given us hints on the energy market outlook for the current fiscal year - constrained and costly. A further tightening in the market and potential increases in prices can derail economic recovery. And this would be in the interests neither of suppliers nor consumers.

Just a couple of weeks back, we had discussed how defaulting can be good for the US. In our view, a technical default can put pressure on the Obama administration to cut spending. You would recall that a technical default means delaying interest payments for a few days.

But the world economy of today is a mind bogglingly interconnected and complex place. A step that may be good for the US economy could, at least for the short term, rattle the global economy. For instance, it could further increase the tension between US and its largest foreign creditor, China. A default would quite likely drive down the value of the US dollar. That would be a big threat to China which holds over US$ 1 trillion in Treasury debt as of March 2011.

Bringing down fiscal deficit level is one of the key promises that the Budget 2011-12 won accolades for. It assured investors in India and abroad about the government's commitment to achieve fiscal prudence. Even a marginal improvement in the fiscal deficit ratio from 4.7% to 4.6% by FY12 seemed relevant. For it meant that the government would make an attempt to grow the economy without relying on excessive debts. The basis of this assumption was tax collections to the tune of Rs 6.6 trillion for the current fiscal. Here again, the GDP growth estimated for the financial year 2011-12 was nearly 9%. Needless to say that the government had been over optimistic in its projections to give the budget a 'feel good' factor. Given the rise in commodity prices and interest rates, it was not very difficult to assume that growth level in FY12 will be lower than that achieved last fiscal. And tax collections are but a reflection of rise in economic output and profitability. Hence it should come as no surprise if the government fails to meet its tax collection target this year. But again, convincing investors that it is on the path of fiscal prudence will be more difficult this time.

For a country whose farm output has been pretty strong over the years, quite a large number of its people ironically have remained hungry. Yes, more than 250 m Indians go to bed hungry every night largely due to the government's apathy in dealing with wastage of food. Food (or the lack of it) has all the more come into the limelight in recent times due to rising prices. The latter especially was a consequence of poor storage facilities as a result of which tons of foodgrain were left to rot.

But all this could now change. The government seems to have realised the urgency of the matter and has appointed a 15-member panel to suggest ways of curbing waste as well as overcoming distribution hurdles that plague its bulging cities. There is wastage of food starting from the point of harvest to procurement, storage, transportation and then at social functions like marriages as well as hotels and restaurants. The panel is expected to submit its report in the next three to four months. However, the important thing for the government to do is act on these suggestions and focus on building warehouses and cold storage facilities to ensure that farm out output does not go waste. Unless there is a willingness to execute and implement, suggestions will remain just that.

Meanwhile, indices in the Indian stock market traded pretty lacklustre today with the Sensex trading around 10 points lower at the time of writing. Most indices in Asia also closed week today whereas Europe has opened on a mixed note.

 Today's investing mantra
"Most of the time common stocks are subject to irrational and excessive price fluctuations in both directions as the consequence of the ingrained tendency of most people to speculate or gamble... to give way to hope, fear and greed." - Benjamin Graham

Today's Premium Edition.

Recent Articles

All Good Things Come to an End... April 8, 2020
Why your favourite e-letter won't reach you every week day.
A Safe Stock to Lockdown Now April 2, 2020
The market crashc has made strong, established brands attractive. Here's a stock to make the most of this opportunity...
One Stock that is All Charged Up for the Post Coronavirus Rebound April 1, 2020
A stock with strong moat is currently trading near 5-year lows.
Sorry Warren Buffett, I'm Following This Man Instead of You in 2020 March 30, 2020
This man warned of an impending market correction while everyone else was celebrating the renewed optimism in early 2020...

Equitymaster requests your view! Post a comment on "Is this the most rational way to invest?". Click here!

7 Responses to "Is this the most rational way to invest?"


Mar 12, 2012

Can you please elaborate on Value investing?how to find out intrinsic value? can you explain the same with one example?



Jun 10, 2011

Value investing IS THE ONLY AND THE ONLY WAY to make money or rather create wealth from the stock markets. Rest all is just plain "satta". Earn once a week and loose on the other four days. And by the way it is never to late to start. MArkets have been working for more than 100 years and will continue to do so for the next 100 yrs. You have to find the gems at the right intrinsic value and hold them for long period.
Also never forget to book partial profits once they have risen 50 to 60%.
Damani S.K.



Jun 9, 2011

A wise investment would be on fundamentals



Jun 9, 2011

I am surprized Pakistan does not feature in the list of top military spenders. Their spend is almost 3.5% of their GDP. May not be high in monetary terms because the latter itself is low, but nonetheless...


Sibert Collaco

Jun 9, 2011

Value Investing is most rational way to invest


Zachaaria Mathews

Jun 9, 2011

Rational, value or wise investment are all buzz words that will not a guide for creating wealth. As it is correctly said, there is no dearth of qualified financial people. Then what is lacking? The system adopted by these financial people for the benefit of the organization by twisting the facts and figures is to be blamed. The current financial systems has no ethical values. A life without ethical values will lead to unethical ways. This is what is actually happening in the financial world. Even we cannot believe anyone, a Broker, A Financial Advisor, a Sales man. They promote the products/services for their own benefit and for the benefit of the organization.

Until and unless a true financial model has been put in place, there will not be any end to the financial troubles.


Pronob Chatterji

Jun 9, 2011

CONGRATULATIONS! You are very right in your conclusion about Value Investing being the most rational way to invest.You have hit the nail on the head.But this process requires time.
The problem for late entrants like me is how we can invest in a secure way for a 5 to 10 year period and yet beat inflation. kindly advise.

Equitymaster requests your view! Post a comment on "Is this the most rational way to invest?". Click here!